TOKYO, June 2 (Reuters) - The yen fell on Wednesday after Japanese Prime Minister Yukio Hatoyama’s resignation stoked expectations that his likely successor, the finance minister, would take a tougher stance in fighting yen strength.

Hedge funds jumped on the resignation news to drive the yen lower, but the drop soon petered out after the euro fell following comments from European Central Bank board member Christian Noyer.

Noyer said in an interview with the German business daily Handelsblatt that the exchange rate of the euro against the dollar is not unusually low. [ID:nSGE65105R] His remarks came a day after the euro hit a four-year low against the dollar.

The yen dropped to a two-week low against the dollar as investors sold on the view that political instability would make the economy more dependent on the Bank of Japan and its easy monetary policy.

Market players speculated that Finance Minister Kan, who doubles as deputy prime minister, would be the likely successor to Hatoyama, which in turn could make investors cautious about pushing the yen higher. [ID:nTOE65101O]

“The market may become cautious over the possibility of government moves to restrain yen strength because Kan has shown his preference for a weaker yen,” said Masafumi Yamamoto, chief FX strategist in Japan at Barclays Capital.

“But given no signs that business leaders have complained to the current government about a higher yen, the chance of Japanese currency intervention remains very low,” Yamamoto said.

The euro looked increasingly vulnerable to another sell-off amid mounting concern that the euro zone’s debt crisis is spreading to its banking system.

The dollar held firm near a 15-month high against a basket of currencies as market players shifted their focus to reports on the U.S. labour market due later this week, which are expected to show a surge in employment and a slight fall in the jobless rate. [ID:nN01175887]

Against the yen, the dollar rose as high as 91.78 yen on trading platform EBS, the highest since May 20, from around 91.10 yen before the first media report on Hatoyama’s resignation.

It later trimmed gains to stand at 91.33 yen JPY=, up 0.4 percent from late New York trade on Tuesday, after the Nikkei share average index .N225 turned lower and Asian stocks fell.

The ruling Democratic Party is struggling to revive its chances in an upper house election expected in July, less than a year after sweeping to power with promises of change. [ID:nTOE65100Q]

The euro rose 0.4 percent to 111.72 yen EURJPY=R, but also trimming earlier gains with investors believing concerns over the euro zone’s debt crisis will outweigh any impact from political instability on Japan’s economy in the wake of Hatoyama’s resignation.

Traders said euro selling pressure was likely to continue as the market grows more confident that the U.S. economy and its banking system are in much better shape than their European counterparts.

“Given the deep-seated bad debts at euro zone banks, this looks like just the beginning of the euro’s long-term slide,” said a sales trader at a Japanese trust bank.

“Reaching parity in euro/dollar in the long-run is becoming increasingly realistic.”

The euro edged down 0.2 percent to $1.2209 EUR=, shedding earlier rises. A senior prop trader for a Japanese bank said market players are less motivated to take big positions in the euro after taking a hit from the currency's sharp upswing on Tuesday.

The single European currency hit a 1-½ year low against the pound at 82.80 pence EURGBP=D4. Sterling gained versus the dollar and the euro after British insurer Prudential (2378.HK) said it was withdrawing from a $35.5 billion deal to buy American International Group Inc’s (AIG.N) Asian life insurance business AIA. [nTOE65100R]

The euro made a brief rebound above $1.23 the previous day after earlier dropping to a four-year low of $1.2110 on trading platform EBS.

It had succumbed to selling pressure on concerns about bad loans held by euro zone banks after the European Central Bank warned this week that euro zone banks faced up to 195 billion euros in a “second wave” of potential loan losses over the next 18 months due to the financial crisis. [ID:nLAG006303]

Talk of a double no-touch option with perimeters at $1.2100 and $1.2500 may also keep the euro range bound against the dollar. Market players said the option expires at the end of the week when U.S. non-farm payroll numbers will be released.

Technical analysts noted that the euro’s break below key support at $1.2135, a 50 percent retracement of the 2000-2008 rally, had accelerated the currency’s slide on Tuesday. A daily close below $1.2135 would suggest further downside, they said.

The dollar index, a gauge of the greenback’s performance against other six major currencies, was at 86.910, near its 15-month high of 87.473 hit the previous day. (Additional reporting by Anirban Nag in Sydney and Kaori Kaneko in Tokyo; Editing by Chris Gallagher)